Recently, Meld’s Social Security and Medicare specialist shared some valuable insights around the ‘earnings test’ and how it can impact those receiving Social Security benefits. Read the short article below to learn if this test applies to your situation and how it might affect your retirement plan.
Social Security and the Earnings Test by Patricia L. Burris, CFP®
The earnings test applies if you claim Social Security benefits prior to your Social Security defined Full Retirement Age [FRA] and continue to work. This rule reduces your Social Security benefits for every dollar you earn over certain thresholds in the years before you reach your FRA.
In 2023, $1 will be withheld for every $2 earned over the annual threshold of $21,240 if you will not reach FRA this year. If you will reach FRA in 2023, $1 will be withheld for every $3 you earn over $56,520. The earnings limit is effective January 1st each year and indexed annually.
Who is Subject to the Earnings Test?
Everyone who is working and receiving Social Security benefits prior to their FRA can be subject to the earnings test. This includes widows, widowers, and minor children receiving survivor benefits. However, the earnings test only impacts those with income over the earnings limit. One exception is a minor child receiving benefits based on a parent’s work history. If the parent is still living and under FRA, the earnings test for the child’s benefit will be subject to the amount earned by the parent.
How is the Earnings Limit Applied?
As previously stated, the earnings limit changes in the year that you will reach FRA. In addition, the earnings limit is applied differently depending on when you begin receiving Social Security benefits.
First Year
You are subject to a monthly earnings test during the first year that you claim Social Security benefits prior to your FRA. The monthly earnings limit is $1,770 in 2023 – 1/12 of the annual limit. The earnings test begins the month you start receiving benefits. Therefore, your income prior to the month you start receiving Social Security benefits is not impacted.
Subsequent Years, Until the Year You Reach FRA
After the first calendar year you begin receiving benefits, you are subject to an annual earnings limit. This limit applies each year until you reach FRA. At the beginning of each year, you will be asked to estimate how much you plan to earn. If your estimated earnings are less than the annual limit for that year – $21,240 in 2023 – no Social Security benefits will be withheld.
The Year You Reach FRA
The earnings limit in the year you reach FRA is only applicable prior to the month you reach FRA and is much higher – $56,520 in 2023. This is a monthly earnings limit if this is the first year you are receiving Social Security benefits. However, it is an annual earnings limit if this is the second or subsequent year you are receiving benefits.
For example, if you were born in July and you reach FRA in 2023, you can earn $4,170 each month January through June if this is the first year you are receiving benefits. If this is the second or subsequent year you are receiving benefits, you can earn a total of $56,520 between January and June before reaching the earnings limit.
What Earnings are Considered When Applying the Earnings Test?
Annual gross earnings reported on your W-2 are used when applying the earnings limit. Therefore, contributing to a 401(k) or similar retirement plan will not reduce earnings for the earnings test. However, payments received “on account of retirement,” such as a severance package, are not subject to the earnings test.
It is important to note that the earnings of your spouse may be considered when applying the earnings test for your benefits in some cases. If you are claiming benefits based on your current spouse’s work record, your spouse is under FRA, and they continue to work, then their earnings are considered when applying the earnings test for your benefits. This is the case even if you have already attained FRA. However, if you are claiming benefits on an ex-spouse’s record, only your current earnings and age are used when applying the earnings test.
Earnings Test for Self-Employed
If you are self-employed, the earnings test is applied differently. Regardless of how much you earn, you must work less than 45 hours per month in your business to avoid having benefits withheld prior to reaching FRA.
How Benefits are Withheld if You Exceed the Earnings Test
Once the Social Security Administration [SSA] determines you have exceeded the earnings test – or will exceed it based on the estimated earnings you provided – they will calculate the amount to withhold. These benefits are withheld immediately. The SSA will withhold full benefit checks until they receive the full amount overpaid, at which time they will resume paying your monthly benefit.
The SSA always withholds full monthly benefit checks, even if the last one withheld exceeds the amount of the overpayment. In this case, the SSA will refund the excess withheld as soon as your employer reports your earnings for the year.
Withheld Benefits Added Back at FRA
At your FRA, the SSA recalculates your monthly benefit to include the benefits withheld due to the earnings test. The calculation to determine your monthly benefit at your FRA is somewhat complicated. The example below will provide a general idea of how your benefit is determined at FRA.
Assume your FRA is 66 and you started taking benefits at age 62. This reduced your FRA benefit by 25%. You start receiving 75% of your Primary Insurance Amount [PIA] of $2,000 for a benefit of $1,500 per month. Also assume 50% of your benefits were withheld due to the earnings test. At your FRA, the SSA will increase your monthly benefit by 50% of your 25% age-62 reduction, or 12.5%. With this increase, your new benefit amount is 87.5% of your PIA, or $1,750.
When to Apply for Social Security – That is the Question
Sometimes it makes sense to apply for Social Security early even if you are subject to the earnings test. For example, a widow or widower who has limited earnings and needs the extra income may need to start receiving Social Security benefits as soon as possible. In this case, they need to make sure they plan accordingly and know that their full Social Security check will be withheld as soon as the SSA becomes aware they’ve earned over the limit.
There are different schools of thought about applying for Social Security prior to FRA. Some advisors think you should wait as long as you can, even to age 70, to apply for benefits so that you get the largest monthly amount available. Others lean toward beginning Social Security at your FRA – or earlier if you are no longer working – if the alternative is withdrawing from retirement accounts to pay your living expenses. After all, your retirement nest egg can be left to your heirs, whereas your Social Security benefits generally cannot. However, sometimes a higher earning spouse needs to delay their Social Security benefits to age 70 to provide a larger survivor benefit at their passing.
When to file for Social Security benefits is a decision that every person needs to fully understand before applying. Your financial advisor can help you determine how Social Security impacts your overall retirement income. If they don’t carefully consider the timing of when you should file for Social Security in your retirement planning discussions, then it’s time to find a new advisor.
Get Answers to Your Social Security Questions with Meld Financial
If you are looking for assistance in planning your retirement, contact a member of the Meld Financial team. We have spent nearly forty years helping clients achieve their retirement goals and we have the experience to answer your most pressing Social Security questions.
Our advisors will develop your Financial Fingerprint™ – a comprehensive financial plan that is quick to assemble, easy to understand, and simple to modify as your circumstances change. This plan accounts for many common retirement challenges such as maximizing benefits from government programs like Social Security.
To learn more about Financial Fingerprint™, and get started today, contact us.
